Sometimes, when you win a prize that's too good to be true, it pays to read the fine print. That's sage advice I'll give to any Qualcomm (Nasdaq: QCOM) investor today. A victory in Apple's (Nasdaq: AAPL) iPhone may seem like an easy road to extra riches, but the fine print of the details will leave an empty feeling that no app can cure.
It's good to be the patent king
Qualcomm enjoys a vast array of patents on the Code Division Multiple Access (CDMA) technology it pioneered. As every 3G network uses CDMA technology, Qualcomm is able to license its patent portfolio in exchange for a royalty payment that's 4-5% of selling prices on 3G enabled phones.
However, the company's expertise goes further than their world-class patent portfolio. The full value of CDMA comes from Qualcomm's experience in implementing this difficult concept. Its deeply held trade secrets and know-how allow it to be a dominant force in the market for chipsets based on the technology.
So, when reports of Apple's intention to sell the iPhone through Verizon (NYSE: VZ) surfaced, it was no surprise Qualcomm was repeatedly thrown about as a potential winner. Verizon operates a CDMA EV-DO 3G network, and Qualcomm has a special expertise designing chipsets in that technology.
Apple, not Qualcomm's friend
However, I think investors fixated on the millions of additional potential chipset sales to Apple are missing the boat. Additional sales of iPhones would help Qualcomm, but at the expense of collecting royalty revenue from other phones that may be more profitable. So get your calculators out, it's time for a lesson in Qualcomm economics.
Reports from Sanford C. Bernstein indicate Apple may have found a loophole in Qualcomm's licensing policy that allow it to pay the estimated wholesale price paid to iPhone manufacturer Foxconn (estimated at $244), instead of the $600 price Apple receives from AT&T. Presuming Qualcomm collects a 4% royalty rate on that $244 price, and if Apple is set to sell 40 million iPhones a year, this loophole is costing Qualcomm nearly $570 million in annual revenue. When you consider that Qualcomm commands 85% pre-tax margins on its licensing segment, that loophole could be costing the company $485 million in pre-tax profits a year!
Android, Qualcomm's real BFF
The bad news? Sales of iPhones at Verizon would likely come at the expense of a sale of a Google (Nasdaq: GOOG) Android phone. Androids are typically high-selling-price phones where Qualcomm collects royalty payments on the full selling price. But don't the additional chipset sales to Apple make up for any royalty price difference?
Probably not. Nailing down the revenue Qualcomm would make from its inclusion in the iPhone is imprecise. However, as a very rough proxy, the company that makes the 2G and 3G communications chips for the current iPhone model, Infineon, has about $14 worth of products in each phone according to researcher iSuppli. Also, don't forget that profit margins on chipset revenue is significantly less than seen on royalty payments.
Oh, and as a final negative, Android phones such as HTC's Droid Incredible have increasingly used Qualcomm's Snapdragon processor. Apple uses its own A4 processor and won't be sourcing processors out to Qualcomm any time soon. For that reason, an iPhone sale on Verizon might cause a further loss of revenue.
As a Qualcomm investor, you're best left rooting for continued Android dominance. The chances of getting not only more revenue, but selling more chips to Android customers are much greater. There are a lot of reasons to like Qualcomm as a stock, but Steve Jobs finally letting the company into his golden phone isn't one of them.
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Eric Bleeker owns shares of no companies listed above. Google is a Motley Fool Rule Breakers recommendation. Apple is a Motley Fool Stock Advisor pick. The Fool owns shares of Google. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.